Attention Biotech Investors: Stop Looking at Share Price

Editor's note: A previous version of this article did not state that VIVUS raised cash through a follow-on offering in 2011. It has been edited to incorporate this information.

How do you track the value of companies you're invested in? If you're like most people, you probably check the increase or decrease in share price.

Hate to tell you this, but you're doing it wrong.

Let me explain...

Don't anchor yourself
After my article on MannKind (NASDAQ: MNKD  ) earlier this week, a reader wasn't too happy about my view that the company was overvalued given the most recent phase 3 data.

"Why was MNKD at 10 last time around at this juncture and suddenly we have everyone wanting to cut it down," the reader asked in an email.

MNKD Chart

MNKD data by YCharts.

The reader is arguing, as you can see from the chart, that MannKind hasn't reached the level it was the last time it was on the cusp of an approval for its inhaled insulin Afrezza. With an approval as likely -- I'd argue, more likely -- than it was in March 2010 and January 2011, before the first and second FDA rejections, shouldn't MannKind be valued as high as it was back then?

Turns out it is. Higher even.

MannKind's share count has doubled since 2011. Since the value of the company -- its market cap -- is the share price times the number of shares outstanding, the value of the company -- the orange line on the graph below -- is much higher than it was in 2011 even after the pullback the last couple of days. The company is worth more, but each share is a smaller portion of the pie.

MNKD Chart

MNKD data by YCharts.

Part of the biotech game
Investors who bought before the last FDA rejection haven't recouped their losses, but it's hard to fault MannKind. Drug development costs money. Capital raises are a necessary evil, and they're painful for investors when cash is needed when valuations sink after surprise rejections.

Here's a look at a few more companies that have had recent failures to illustrate the point. The theoretical share price is based on the 2011 weighted average diluted share outstanding and the current market cap. Essentially it's the price if the company hadn't sold any shares recently.

Company

Share Price Aug 16, 2013

Theoretical Share Price

Potential Increases Investors Missed

MannKind

$5.77

$13.46

133%

Arena Pharmaceuticals (NASDAQ: ARNA  )

$6.83

$10.70

57%

VIVUS (NASDAQ: VVUS  )

$12.28

$14.49

19%

Orexigen (NASDAQ: OREX  )

$6.84

$13.88

103%

Source: S&P Capital IQ.

The FDA sent all three obesity drug companies -- Arena, VIVUS, and Orexigen -- back to the drawing board, causing share prices to drop. Arena and VIVUS were eventually able to get their drugs approved without any additional clinical trials, but Orexigen had to run a large safety study, necessitating a large capital raise. Its market cap also dropped the lowest of the three, making raising cash more dilutive to shareholders.

There's one more moral to this story. While the table makes VIVUS look like a saint, the company did raise a little cash in 2011. Even with that raise, though, VIVUS has been a little more judicious with its cash, increasing its share count by 25% over the last three and a half years compared to Arena, which increased its share count by 142% over the same time frame.

Foolish take-home message
Investors would be much better off if brokerage firms and finance websites would give quotes in market caps rather than share prices. Over the short term, share price is an OK indication in change in value, but over the longer term, share price becomes fairly meaningless as companies sell shares, diluting current shareholders. As an added bonus, it would give investors a relative valuation compared to its peers.

It's no secret that biotech valuations have been soaring recently, but the best investment strategy is to pick great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" not only shares stocks that could help you build long-term wealth, but also winning strategies that every investor should know. Click here to grab your free copy today.


Read/Post Comments (5) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 20, 2013, at 10:40 AM, marp11 wrote:

    the absolute last ones to be giving advice to any investors,,,,well guess who?

  • Report this Comment On August 20, 2013, at 10:49 AM, HScott23 wrote:

    What you fail to recognize is last time around the NDA was filed just for Type 1 diabetes which represents maybe 5% of the diabetic population. This NDA which they are filing in October will be for Type 1, Type 2 and pre- diabetics. You do the math. Sounds like a price of $47.50 would be more inline with your analysis.

  • Report this Comment On August 20, 2013, at 11:29 AM, steelpoker wrote:

    I am a strong believer in MNKD and agree with Hscott23 that the potential is larger now than before. There are still multiples to be made in this stock.

    That being said, this is one of the more useful Motley Fool pieces I have seen in a LONG while. I had been curious what the relative share vs market cap chart looked like. Thanks for the helpful insights, Brian!

  • Report this Comment On August 20, 2013, at 4:05 PM, athalon7 wrote:

    "It's no secret that biotech valuations have been soaring recently, but the best investment strategy is to pick great companies and stick with them for the long term"

    Maybe best for you. I know a person that made a boatload of money with call options on Mannkind and is way out of them now. That really is the bottom line. Its an artform to trade companies with 1 or 2 products and a trial coming up.

    Now she got in early with OPKO. Already up a boatload of money, she will hang on to this one because they have over 500 employees and a slew of products that will reap tremendous rewards for early investors.

  • Report this Comment On August 20, 2013, at 10:25 PM, vireoman wrote:

    Given MNKD's torturous history with the FDA, including a last-minute, blindside rejection that was interwined with an insider-trading scandal involving an FDA employee, should there be any surprise that there has been some need to raise additional capital by selling shares? If MNKD wasn't spearheaded by a philanthropic billionaire determined to bring Afrezza to market, this product would have vanished long ago. While I'm an investor and not a diabetic (yet), from all indications, this would have been a tragic event for diabetics, many of whom crave an effective alternative to daily injections.

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